What Is a Home Equity Line of Credit (HELOC)?

A HELOC Allows You to Borrow Against the Equity of Your House

A home equity line of credit, more commonly known as a HELOC, is a way of borrowing money against the value of your home. If your house is worth more than you owe on your mortgage, you may be able to use your home equity to pay for improvements, consolidate high-interest debt, or cover college tuition.

What Is a HELOC?

HELOCs are often considered second mortgages because you are borrowing against the equity in your home. However, they work a little differently from your classic mortgage loan, where you borrow a set amount upfront, choose a fixed or variable interest rate, and make regular payments over time.

Instead, HELOCs are lines of credit that let you choose how much money you borrow, up to a certain limit, during a designated timeframe called the draw period, usually of 5 to 10 years. You will pay interest at a variable rate during this draw period. Eventually you’ll enter a repayment period, usually of 10 to 20 years. You'll then pay both principal and interest.

Unlike with a cash out refinance or home equity loan, you don't need to take out all the money at once with a HELOC, so home equity lines of credit can be useful when you’re not sure exactly how much you’ll need to borrow. You might consider a HELOC when you're planning home renovations but don't know how much money you’ll need or when you’ll need it. You might also get a HELOC to pay for college tuition when different bills come due at different times.

The interest-only payments during the draw period can make the upfront costs of a HELOC more affordable. However, HELOCs typically come with a variable interest rate, which means the amount of your interest payments will vary over the life of the loan.

Be aware that a HELOC uses your home as collateral. This means that if you have trouble making payments or default on your HELOC, you risk losing your home.

Example of How a Home Equity Line of Credit Works

To better answer the question, what is a home equity line of credit, let's take a look at how a HELOC could work.

• You apply for a line of credit, and your lender determines you have $50,000 of equity available in your home that you can borrow against. The amount is based on the combined value of all your loans relative to what your home is worth.
• You're given a $50,000 line of credit you can access over a draw period. In this case, let's say your lender allows you to access the line of credit over 10 years.
• You only need to borrow $20,000 right now for home improvements. You borrow that amount, leaving $30,000 of untapped credit you can access later if you need it.
• You make monthly payments based on the amount you borrowed. You'll usually only pay interest at the time, and monthly payments vary based on your interest rate at the time since HELOCs are variable rate loans.
• You need to borrow another $5,000 to make some additional home upgrades. You borrow that amount, leaving $25,000 available to borrow if you need it. Your monthly payment now takes into account the extra $5,000.
• The draw period ends and the repayment period begins. Eventually your draw period ends and you start making payments on the principal.

As you can see, this provides a lot of flexibility for how you manage your money.

HELOC Requirements

There are certain requirements you must fulfill to be eligible for a loan. The specifics can vary by lender, but this is what you will need as a general rule:

• Equity in your home: Lenders won't give you loans, including a HELOC, that exceed a certain percentage of your home's market value. This percentage is usually around 80% to 90% of what your home is worth.
• Good credit: Most lenders require you to have a good credit score, or at least fair credit. Freedom Mortgage requires a minimum credit score of 640 to obtain a HELOC. You can check your credit reports to see if there are any problems with your record that would impact your ability to borrow.
• Debt-to-income ratio: Lenders consider your debt relative to your income. That debt calculated would include your potential HELOC. The maximum debt-to-income ratio for mortgages and HELOCs varies by lender but is usually 45% or under.
• Proof of earnings and employment: You'll have to prove how much you earn and show that you're steadily employed. Lenders usually like two years of stable employment.
• Home insurance: Lenders want to make sure that your property is insured.

Since the requirements for a home equity line of credit vary by lender, it's best to speak with a mortgage professional about their specific requirements. A loan advisor at Freedom Mortgage can help you walk through your options.

HELOC Pros and Cons

If you are thinking about applying for a home equity line of credit, here are some of the biggest advantages and disadvantages to consider.

HELOC Alternatives

In addition to HELOCs, you can also get cash from your home's equity with a refinance or a home equity loan.

• Cash-out refinances: A cash out refinance allows you to access your home equity while refinancing your current loan. You get a new loan with a new rate and terms, and you can use it to pay off your old loan and use what’s left for nearly anything.
• Home equity loans: A home equity loan is a second mortgage on your home that provides a lump sum you can borrow. Rates are often fixed, and you pay your loan back on a set schedule, providing predictability.

Home Equity Line of Credit FAQs

If you still need to know more about how a HELOC works or if a home equity line of credit is right for you, the answers to these frequently asked questions can help.

What Credit Score Do You Need for a HELOC?

Credit score requirements for a HELOC vary by lender. While Experian reports most borrowers need a minimum score of 680 to qualify for a HELOC, and ideally a score closer to 720, some lenders will accept lower scores. Freedom Mortgage requires a minimum credit score of 640.

Is Getting a HELOC a Good Idea?

Getting a HELOC can be a good idea if you have equity in your home and need access to a line of credit you can draw from as needed. However, before you get a home equity loan, be aware that borrowing against your home can put you at risk of foreclosure if you miss payments. You should also consider how HELOC rates are variable and can change over time.

Is HELOC Interest Tax-Deductible?

HELOC interest can be tax-deductible under certain circumstances. You may be able to deduct your interest if you use the funds you borrow to substantially improve the home securing the loan. However, you must itemize your deductions. Be sure to ask a tax professional before you itemize to confirm you are eligible and that it's the best way to lower your tax bill.

Let Freedom Mortgage Help You Use Your Equity

Freedom Mortgage can help you access home equity by walking through the benefits of using a HELOC or cash-out refinance depending on your needs. Get started online and select “Get Cash From Your Home’s Equity.”